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The greatest number of jobs is created when startups create a new market – one where the product or service never existed before or is radically more convenient. Yet this is where startups will run into anti-innovation opponents they may not expect. These opponents have their own name – “rent seekers” – the landlords of the status-quo.

Smart startups prepare to face off against rent seekers and map out creative strategies for doing so…. First, however, they need to understand what a rent seeker is and how they operate…

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Recently, the New York and North Carolina legislatures considered a new law written by Auto Dealer lobbyists that would make it illegal for Tesla to sell cars directly to consumers. This got me thinking about the legal obstacles that face innovators with new business models.

While Tesla, Lyft, Uber, Airbnb, et al are in very different industries, they have two things in common: 1) they’re disruptive business models creating new markets and upsetting the status quo and 2) the legal obstacles confronting them weren’t from direct competitors, but from groups commonly referred to as “rent seekers.”

Rent SeekersRent seekers are individuals or organizations that have succeeded with existing business models and look to the government and regulators as their first line of defense against innovative competition. They use government regulation and lawsuits to keep out new entrants with more innovative business models. They use every argument from public safety to lack of quality or loss of jobs to lobby against the new entrants. Rent seekers spend money to increase their share of an existing market instead of creating new products or markets. The key idea is that rent seeking behavior creates nothing of value.

These barriers to new innovative entrants are called economic rent. Examples of economic rent include state automobile franchise laws, taxi medallion laws, limits on charter schools, auto, steel or sugar tariffs, patent trolls, bribery of government officials, corruption and regulatory capture. They’re all part of the same pattern – they add no value to the economy and prevent innovation from reaching the consumer.

No regulation?Not all government regulation is rent or rent seeking. Not all economic rents are bad. Patents for example, provide protection for a limited time only, to allow businesses to recoup R&D expenses as well as make a profit that would often not be possible if completely free competition were allowed immediately upon a products’ release. But patent trolls emerged as rent seekers by using patents as legalized extortion of companies.

How do Rent Seekers win?Instead of offering better products or better service at lower prices, rent seekers hire lawyers and lobbyists to influence politicians and regulators to pass laws, write regulations and collect taxes that block competition. The process of getting the government to give out these favors is rent-seeking.

Lobbyists also work through regulatory bodies like FCC, SEC, FTC, Public Utility, Taxi, or Insurance Commissions, School Boards, etc. Although most regulatory bodies are initially set up to protect the public’s health and safety, or to provide an equal playing field, over time the very people they’re supposed to regulate capture the regulatory agencies. Rent Seekers take advantage of regulatory capture to protect their interests against the new innovators.

PayPal – Dodging BulletsPayPal consistently walked a fine line with regulators. Early on the company shutdown their commercial banking operation to avoid being labeled as a commercial bank and burdened by banks’ federal regulations. PayPal worried that complying with state-by-state laws for money transmission would also be too burdensome for a startup so they first tried to be classified as a chartered trust company to provide a benign regulatory cover, but failed. As the company grew larger, incumbent banks forced PayPal to register in each state. The banks lobbied regulators in Louisiana, New York, California, and Idaho and soon they were issuing injunctions forcing PayPal to delay their IPO. Ironically, once PayPal complied with state regulations by registering as a “money transmitter” on a state-by-state basis, it created a barrier to entry for future new entrants.

U.S. Auto Makers – Death by Rent SeekingThe U.S. auto industry is a textbook case of rent seeking behavior. In 1981 unable to compete with the quality and price of Japanese cars, the domestic car companies convinced the U.S. government to restrict the import of “foreign” cars. The result? Americans paid an extra $5 billion for cars. Japan overcame these barriers by using their import quotas to ship high-end, high-margin luxury cars, establishing manufacturing plants in the U.S. for high-volume lower cost cars and by continuing to innovate. In contrast, U.S. car manufacturers raised prices, pocketed the profits, bought off the unions with unsustainable contracts, ran inefficient factories and stopped innovating. The bill came due two decades later as the American auto industry spiraled into bankruptcy and its market share plummeted from 75% in 1981 to 45% in 2012.

In these states it appears innovation be damned if it gets in the way of a rent seeker with a good lobbyist.

Much like Paypal, it’s likely that after forcing Tesla to win these state-by-state battles, the auto dealers will have found that they dealt themselves the losing hand.

Rent seeking is bad for the economyRent seeking strangles innovation in its crib. When companies are protected from competition, they have little incentive to cut costs or to pay attention to changing customer needs. The resources invested in rent seeking are a form of economic waste and reduce the wealth of the overall economy.

Startups, investors and the public have done a poor job of calling out the politicians and regulators who use the words “innovation means jobs” while supporting rent seekers.

What does this mean for startups?In an existing market it’s clear who your competitors are. You compete for customers on performance, ease of use, or price. However, for startups creating a new market – one where either the product or service never existed before or the new option is radically more convenient for customers – the idea that rent seekers even exist may come as a shock. “Why would anyone not want a better x, y or z?” The answer is that if your startup threatens their jobs or profits, it doesn’t matter how much better life will be for consumers, students, etc. Well organized incumbents will fight if they perceive a threat to the status quo.

As a result disrupting the status quo in regulated market can be costly. On the other hand, being a private and small startup means you have less to lose when you challenge the incumbents.

If you’re a startup with a disruptive business model here’s what you need to do:

Map the order of battle

Laughing at the dinosaurs and saying, “They don’t get it” may put you out of business. Expect that existing organizations will defend their turf ferociously i.e. movie studios, telecom providers, teachers unions, etc.

Understand who has political and regulator influence and where they operate

Figure out an “under the radar” strategy which doesn’t attract incumbents lawsuits, regulations or laws when you have limited resources to fight back

AirBnb – Damn the torpedoes full speed ahead
For example, Airbnb, thrives even though almost all of its “hosts” are not paying local motel/hotel taxes nor paying tax on their income, and many hosts are violating local zoning laws. Some investors and competitors may be concerned about regulatory risk and liability. AirBNB’s attitude seems to be “build the business until someone stops me, and change or comply with regulations later.” This is the same approach that allowed Amazon to ignore local sales taxes for the last two decades.

When you get customer scale and raise a large financing round, take the battle to the incumbents. Strategies at this stage include:

Use competition among governments to your advantage, eg, if New York or North Carolina doesn’t want Tesla, put the store in New Jersey, across the river from Manhattan, increasing New Jersey’s tax revenue

59 Responses

Other rent seekers (of epic proportions) are the companies in the beer/wine/spirits distribution business. They have a monopoly over a distribution system that drives up prices while stifling entrepreneurial activity. More proof (pun intended) that legislators do not care about anything but getting contributions to get reelected, and routinely sell out their constituents for just a very few dollars…..

Yep. Unfortunately that industry is written into the Constitution, so very little change for meaningful reform.

Interestingly, I think something similar is going to happen with marijuana as it becomes more mainstream. Already to get a license in Connecticut you have to post a $2 million bond, and they’re only allowing 10 licensees.

In Texas there are basically only a handful of Beer and wine distributors in the entire State. New entrants are basically unheard of because of bureaucratic barriers that make it difficult to get the “rights” to any territories. Pretty far from a fair market system but doesn’t impact have a drastic effect on the producers so there’s not govt. action.

It must be considered that there is nothing more difficult to carry out nor more doubtful of success nor more dangerous to handle than to initiate a new order of things; for the reformer has enemies in all those who profit by the old order, and only lukewarm defenders in all those who would profit by the new order; this lukewarmness arising partly from the incredulity of mankind who does not truly believe in anything new until they actually have experience of it.

Thanks Steve, for bringing up an important and seldom mentioned problem in the American economy. The only issue less discussed then ‘rentiers’ is the ‘capital strike’ that has been going on for the past half decade. Keep up the good work!

I found a couple typos:
Not all government regulation is rent or rent seeking. Not all economic rents are bad. Patents for example, provide protection for a limited time only [, to] allow businesses to recoup R&D expenses as well as make a profit that would often not be possible if completely free competition were allowed immediately upon a products’ release.
“Why would anyone not want a better x, y or z?” The answer is that if your startup threatens their jobs or profits, it doesn’t matter how [much] better life will be for consumers, students, etc. Or…life will be better for consumers, students, etc.
Thanks again!

This dynamic also occurs in networked markets where very large PE Driven messaging services rollup several former competitors, and use their layer seven routing border power to harm the smaller, innovative competitors. Such is happening in Loren Data Corp v. GXS, presently having gone all the way to the Supreme Court.

Steve reminds us that innovation, while an economic necessity for job and productivity growth, has many enemies. Entrepreneurs must be aware of the battlefield they are entering and must avoid a frontal attack when entering a market that will cause the incumbent reflux. Entering downstream markets that lack the interest of the incumbent(s) is usually the way to go. It will then take time for the incumbent to wake up to the fact that there is a battle.

I am experiencing this from our VA right now in Hawaii as we work to help Veterans rebuild their lives. While our goal is to work with the Veteran in the community the VA is acting like they do not want us to have that ability. They are the classic example of “rent seekers”. This has encouraged me as I will be continuing to define our space, I now know that someone else sees the truth about the establishment. Thanks for sharing this information : )

Extremely well said Steve. Adapting some content from a previous comment I placed on Jeff Howe’s crowdsouring blog…

It seems that no matter how many times history plays out the hand dealt to inefficient markets, the next inefficient market to be assailed wails in protest. It seems that they would have resisted enabling stock trades to happen through anything but a paid broker, or that they are on the side of real estate agents in their fight with the discount agents or websites that perform similar services without the 6% fee.

It’s crazy that folks don’t look at the markets that bloom around the growth that happens when inefficiencies are eliminated. Turns out that stock brokers didn’t go out of business, but rather provide value added services to a market of American investors that is 10 times the percentage is was pre-online trading (less than 5% to over 50% of Americans). This huge increase in the market and volume has increased the need for professional help.

Steve’s example is similar to the scenario where the NO!SPEC folks raised up against the crowdsourcing of graphical design work. As a startup software design company our limited budgets at the beginning only enabled us to pay for ‘logo’ work rather than the real design overhaul that only a professional can deliver (doesn’t do much good to have a professional design if you then can’t afford to the production graphics work to execute on it). So, instead of getting this seriously value added service, we paid through the nose for a few logos that in the end did not really coalesce into a nice U.I. Now, we simply Smartsource* that kind of work out for a few dollars apiece once the pros create our branded design and layout. We’re paying the high margin fees to those folks that actually have differentiated talent instead of pittering away lesser fees on one of the space saturating multitudes.

There is no need for graphic designers to panic. By making the access to truly commodity graphics services very cheap and efficient, the budgets available for the skilled work that can never be commoditized will increase. That’s all good.

I’m a fan of your thoughtful blog and appreciate the insights. The overall takeaway — navigating the regulatory process for startups requires the same type of improvisation and focus as other parts of the business — strikes me as correct. Three additional observations about this topic: (1) missing from this post is that job creation is not a one-sided equation. Those of us in the tech community — me included — are often guilty of rhetoric celebrating a new industry as an unmitigated good. Consistent with Schumpeterian destruction, one person’s job creation is another’s (or, increasingly, multiple individuals’) job loss. To be clear, at the end of the day, I’m convinced that if creative destruction does not occur in the U.S., that wealth and new job creation will just move abroad. But if you’re trying to understand rent seeking, one function of the regulatory process is to attenuate the rate of change and soften the shocks of the market. And (2) for new companies in regulated industries, the political process can be viewed as a double edged sword. Yes, the regulatory process provides opportunity for incumbents to slow or frustrate entry of startups. But for startups companies that nonetheless succeed in “winning” despite the regulatory state, then regulatory process then often becomes a means of buffering a company against future competition. And (3) it is under appreciated how profoundly social media has leveled the playing field for startup voices in the regulatory process. The ability of the Internet community to mobilize and stop SOPA / PIPA is a fascinating study of the dropping costs for startups to mobilize and exert influence on regulatory outcomes. More locally, here in Colorado, Uber put on an impressive grass-roots full court press that favorably helped its cause. This is a trend to watch going forward.

SOPA/PIPA was defeated because so many Internet companies were against it. With further iterations, more and more of those same companies are being horse traded with and the opposition is being softened. Lobbyists are rent seeking specialists.

As long as there is an advantage to doing so, businesses will compete as hard in the regulatory game as they do in the marketplace. My point is that the costs for startups and emerging companies to aggregate their interests and participate before legislative and regulatory bodies have dropped in a manner that few have noticed. You’re almost certainly correct that another formulation of SOPA/PIPA will be presented. But the playing field for startups to band together, while not by any means level with incumbents, is more playable than in the age before social media.

Do jobs in a newly minted market segment cause a one-to-one decrease in jobs in the aging market segment, or does the new market merely cause the old guard to pivot and focus more on value-add products/services?

I wonder whether PayPal’s ascent correlated with a reduction in jobs in the banking industry.

“being a private and small startup means you have less to lose when you challenge the incumbents” – I really want to believe this, but it’s not a fair fight. Startups’ focus on customers and product development is their competitive strength, and legal battles can be a burden few can afford.

“They use every argument from public safety to lack of quality or loss of jobs to lobby against the new entrants. Rent seekers spend money to increase their share of an existing market instead of creating new products or markets. The key idea is that rent seeking behavior creates nothing of value.”

By connecting these thoughts without qualification, you create the impression that all government regulations concerning public safety are forms of rent seeking. This is wrong to the point of recklessness, as countless examples of tragic fires and building collapses in unregulated overseas work environments have proven.

To use two of your examples, Lyft and AirBnB create provider-to-consumer interactions that can be exploited by criminals in ways their traditional, regulated competitors do not. I’m not saying they are necessarily acting in an unsafe manner (I know their executives have considered the issue and developed procedures to reduce risk), but there is no open-and-shut case for why these businesses should not be regulated for safety.

Awesome that you take the time to reply, thanks. I did read the entire post, including the words you quote. And I agree with your larger point. I just felt it was unfair to connect safety regulations and rent seeking without “in line” qualification, given what’s at stake. Not all your readers share your nuanced understanding of the issues, I’m sure.

The same thing has been happening with newspapers and legal ads, i.e. public notices. State and local governments pay out our tax dollars to newspapers to print information that is easily accessible online for free.

They also force private parties to pay for these notices. During the housing downturn, this money poured into newspapers as foreclosures flooded the market, and each one required paid public notices to be printed. This government subsidy has kept a bad business model alive and stifled innovation.

Newspapers have spent a lot of money lobbying governments to keep these subsidies. Their arguments to maintain the status quo are sometimes hilarious, such as that someone might hack into a website and change the information, without noting that the newspapers get the info from the same source.

To me Elon is my Superman, Arnold,Bruce Lee, Einstein, Tesla,Fuller,etc. al in one with his noble dream of creating disruptive businesses to change the world…
I cannot believe that in the greatest “democracy” in the world you cannot sell your better product directly due to lobbyists and “rent seekers”( I like this term :-)). Please all share and sign this petition to help innovators like Musk change the world…

Yeah and in Virginia they just passed some taxes that will be applied to anyone owning an electric or hybrid vehicle (and VA is not even one of the most conservative states!). Most of us are afraid they will also seek to tax bicycles or pave over our beloved bike trails…

One way to fight this obtuseness is not to vote Republican\Tea Party\Libertarian. These clowns are definitely NOT innovation’s friend!

Steve, I have not read all the comments here. Maybe someone addresses this. Airbnb hosts are required to pay their taxes, and Airbnb makes it mandatory that they receive or file an income tax form for this income.

An answer for Tesla is to incorporate, and own, their own dealerships jn states like NC. Historically, Ford and GM did this through foreclosure of dealer assets, then leasing the stores to new operators. Cracker Barrel restaurants follows a similar strategy, in that that the stores are operated by a publicly traded subsidiary as franchises of the privately held parent.

Steve, this is a great post, thank you, and illustrates very well what it is clear is a big challenge for innovators. The “press on” attitude of Airbnb and the like, in the face of considerable opposition. Your suggestions on how to tackle the issues are great.

My favorite example is how the container ships managed to convince the NY longshoreman’s union to accept the new technology.
In 1960 the Union negotiated container royalties — year-end payments to longshoremen based on the weight of cargo moving through their ports.
In 1964, as containerization was really hitting the docks, New York’s longshoreman’s union managed to establish a now-defunct guaranteed annual income for their members, which allowed longshoremen to collect as much as $32,000 a year for doing no work at all after they lost their jobs.

The rent seekers will not win if judges engage both the facts and the constitution to see economic protectionism for what it is: an injustice that is not only wrong, but unconstitutional. It violates the rights of entrepreneurs and consumers.

The Institute for Justice, a libertarian public interest law firm, has for 20 years advanced economic liberty through strategic litigation. We have been successful getting courts to look skeptically at rent seeking–for the first time since the New Deal–and to declare in some cases that economic protectionism is simply not a legitimate governmental interest. Readers might be interested in this recent article from IJ’s newsletter: http://ij.org/l-l-2-13-entrepreneurs-and-ij (discussing protectionism involving transportation startups like Uber and the battle going on between food trucks and restaurants in many cities).

Our cases are not high-tech, but the precedents we are setting are high impact and apply beyond the individual circumstances. For some recent encouraging signs, readers might be interested in two of our current economic liberty cases:

Thanks for bringing attention to the issue. Disclosure: I am an attorney at IJ. I pursued the career in litigation as a way to express my passion for economic liberty, after a successful run co-founding and selling an ecommerce company in the telecom space.

true enough, but the rent seekers have the cash, and lawyers to keep you out of court until you give up or die, and if you do win they will appeal, because winning is keeping you from doing business, not winning the case.

That is why public interest law in defense of economic liberty is needed. Private litigants often can’t afford, or are in a position that they cannot practically seek, a better result. A movement to change the way judges consider economic liberty is needed today, which is what I believe IJ and some other firms are pursuing. See, e.g., http://www.ij.org/cje

Great article, Steve. I think it underscores the reality that we deal with not only in business issues, but (perhaps more) social issues as well. We have a tendency to grant an advantage to the status quo in a very “the-way-it-was” kind of mentality. On the contrary we need to get closer to a practice where the status quo is admitting that anything that has been in place for 20 years, at the very least, is due for reassessment if not an overhaul.

Sustainability faces this headwind just as much as anything else these days–again, both inside the business world and in our sea of associated cultural norms. The attitude of evolution may be better now than it was 15 years ago, but it seems like we still have a ways to go.

Tesla is an interesting example. They are innovators but they are also heavily subsidized by transfer payments from other auto producers in order for them to meet emissions laws. That makes them an interesting hybrid rentier/innovator.

And let it be noted that there is no more delicate matter to take in hand, nor more dangerous to conduct, nor more doubtful in its success, than to set up as a leader in the introduction of changes. For he who innovates will have for his enemies all those who are well off under the existing order of things, and only the lukewarm supporters in those who might be better off under the new. This lukewarm temper arises partly from the fear of adversaries who have the laws on their side and partly from the incredulity of mankind, who will never admit the merit of anything new, until they have seen it proved by the event.

Just for exactness: “The patent rights for utility patents will have a life of 20 years starting on the filing date of patent application or 17 years starting on the issue date of patent grant.” A patent typically takes 3 to 8 years to issue so the 17 years from issue date is a pretty good rule of thumb.

Don’t forget how Amazon is now trying to screwup online sales for smaller companies by encouraging state sales tax 9or internet tax) lobbying….just because now they want to do same day or next day delivery and have multiple warehouse locations.

I was at GM in the 80’s when increasing corporate average fuel economy (CAFE) standards were being imposed. GM is a classic rent seeker and their response to CAFE was summed up perfectly be an engineering director… “We hire 500 lawyers to fight it. Toyota hires 500 engineers and does it.”

EXACTLY what I told the people running the focus group I was invited to in the mid 70’s, as someone who had bought a Honda Civic CVCC. It was fairly obvious that the research was being conducted for GM, trying to find out why so many people were buying those funny little foreign cars.

Great write up! This also applies to so many other areas, from large corporations internal personal (ladder climbers) to start-ups failing to be dynamic enough to change. Opportunity knocks for those who can follow though and make change happen.

At some point “rent seeking” becomes so oppressive the only answer is revolution. This is what Marxist’s mean by “land reform”. The question with monopoly capitalism is: At what point do the ugly side-effects of “rent seeking” become so stifling to the service of the greater good that nationalization needs to be invoked?

Quite frankly, in the United States the largest “subscription services” (health care, big pharma, big energy, telecommunications, even the financial services industry) , position themselves to become “rent seeking” entities often milking their consumers right into bankruptcy. Was the re-finance craze a symptom of rent-seeking by the financial services industry for example? Did the government encourage the mortage credit boom through lack of regulation?

It is heroic enough to see innovation as revolutionary and “anti rent-seeking”. But the truth is that unless capitalism is regulated with frequent and periodical rigor, all enterprise descends towards monopoly and “rent seeking”. “Creative destruction” hardly stands a chance to accomplish any meaningful market evolution as long as no one cares how many worthless CDOs are sold.

Word. All Tesla had to do was put their showroom in the Short Hills Mall in Jersey where all the rich New Yorkers shop tax-free anyway. Next to Gucci, Dolce and Nieman Marcus. Test drive cars sit in the parking lot like eye candy for everyone entering/exiting. “Lets go to the mall, and buy A CAR!” Seriously, it’s like the Apple store. You’re buying a piece of tech, not an automobile in stereotypical automobile fashion. The price is the price, no bullshit. Elon got his game tight and he’s humble about it from a lot of interviews I’ve seen. Dude would probably love for someone else to come along and improve what he’s started (well, continued). Short of revealing his exact battery chemistry, he’s pretty open about his company, well, until you ask about the space ships.

There are some really extreme examples of rent-seeking in industries where the industry NEVER did anything useful. For instance, the lawyers who invented “software patents”, which the software industry didn’t want and didn’t need (software is covered by copyright), and which are violations of basic patent law (they’re “patents” on pure mathematics, which has been excluded from patentability forever) have managed to divert hundreds of millions of dollars to lawyers for absolutely no reason whatsoever. Now everyone *has* to pay those “patent lawyers”.

Pure rent-seeking. Not an organization which lost its ability to compete — an organization which *never* competed and *never* did anything useful, setting up an obstructive “toll gate”.

I’m much more sympathetic to folks like the longshoremen, who got a payoff for the end of their industry, than to the patent lawyers, who got a payoff for *actually damaging* the functioning of the software industry.